As an incorporated health professional, you are both a shareholder and an employee of your professional corporation. This provides tax flexibility when withdrawing funds for personal use because you can withdraw them as salary (and bonuses) and/or dividends. Determining your optimal salary/dividend mix should be reviewed at least annually considering the following:
- Your personal needs for money (versus enjoying the tax deferral for funds left in your corporation);
- The type of income earned by company (i.e. tax rate on dividends and the company’s tax savings from a salary deduction differ for practice income up to $500,000, practice income of $500,000 or more, and investment income), and
- Personal and corporate tax rates in both current and future years.
Canada has an integrated tax system which means that, in theory, the after-tax cash for a salary and dividend strategy will generally put you in the same tax position. A dividend strategy shifts some of your tax burden to the company and reduces your personal tax burden. However, there are some distinct differences that need to be considered when comparing salary and dividend strategies.
Salary Considerations
Salary is added to your income and then taxed at your marginal personal tax rate. Your corporation can deduct your salary, which reduces its income and the amount of tax it pays.
Your salary is subject to deductions on your pay cheque for your personal income taxes and your portion of CPP contributions. Your corporation must make a matching contribution to the Canada Pension Plan (which it can deduct in determining its taxable income). The CPP contributions do represent an additional outlay, compared to dividends, but they will ultimately increase your CPP entitlement. Some individuals pay sufficient salaries to maximize their CPP contributions
A salary allows you to claim certain non-refundable tax credits, which reduce your personal income tax payable. For example, there are tax credits based on your CPP contributions and also for the “Canada Employment Amount” (which was a maximum of $1,245 in 2020). As well, unlike dividend income, a salary allows child care deduction, if this is applicable.
Drawing a salary is necessary if you want to contribute to a registered retirement savings plan (“RRSP”), an Individual Pension Plan (“IPP”) or a Retirement Compensation Arrangement (“RCA”). For example, to be eligible to make the maximum 2023 RRSP contribution of $30,780, requires a salary of $171,000 in 2022.
Dividend Considerations
Dividends are a distribution of your corporation’s after-tax earnings to you, in your role as shareholder. They are included in your personal income and taxed at a preferential tax rate since the company has already paid tax on its earnings. Unlike salaries, your company does not claim a deduction for dividends paid. Dividends are not subject to any tax withholdings, so you should plan for the personal tax that will be assessed when you file your personal tax return.
If you are reporting only dividends, you should also watch for the potential application of CRA’s “Alternative Minimum Tax”.
Need help determining your optimal salary/dividend mix? The experienced team of professionals at Ernst and Company is available for personalized assistance. Contact us today.
